European regulators finalised the start date for the mandatory clearing of swaps on Wednesday, accelerating the timeframe for the largest buyside firms. Here is Financial News's guide to what this means for market participants and what happens next.

The European Securities and Markets Authority confirmed which type of interest rate swaps – by far the largest tranche of the swaps market – will need to be cleared, and the timeframe for the process.

Under G20-led reforms, over-the-counter derivatives that can be standardised will need to be processed through clearing houses, rather than being managed privately between counterparties. The US was the first of the G20 countries to make good on its promise by introducing clearing on a phased basis last year.

Esma, which is responsible for the detailed technical standards that underpin the EU’s swap reforms, confirmed on Wednesday that for the most sophisticated users, primarily banks and brokers, certain interest rate swaps will need to be cleared from the middle of 2015.

Larger buyside firms will be required to start clearing the swaps from around the end of 2015, a timeframe which has been brought forward by six months from the original start date.

Steven Maijoor, chair of Esma, described yesterday’s standards as a “significant milestone for the EU in fulfilling its G20 commitments and promoting international convergence on derivatives market reform”.

Financial News answers 10 key questions on yesterday's standards.

What has happened?
Esma has for the first time begun to specify which types of swaps will need to be cleared under the European Market Infrastructure Regulation. Emir is the EU’s response to a commitment made by G20 countries in 2009 to reduce risk in OTC markets, primarily through the adoption of central clearing and trading obligations, as well as reporting requirements.

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Emir was agreed at a political level earlier this year, and it has been the job of Esma to determine how to implement it by creating so-called regulatory technical standards. On Wednesday, it released the final standards for the central clearing of interest rate swaps, following an industry consultation during July and August.

Which swaps will need to be cleared?
Esma has said that four classes of interest rate swaps will need to be cleared: fixed-to-float interest rate swaps, often known as plain vanilla swaps; float-to-float or basis swaps; forward rate agreements; and overnight index swaps. This clearing mandate will relate to the most liquid swaps ̶ those denominated in euro, dollars and sterling. For vanilla and basis swaps this will also include yen-denominated products.

Why is this so important?
It starts the clock ticking on mandated clearing, a process by which a central counterparty stands between a buyer and seller to mitigate the risk that either defaults. It is a big change for the OTC markets, where trades have traditionally been conducted privately between banks. It means firms will face extra costs because they will be required to post collateral, or margin, against each trade to cover the costs of any default. Interest rate swaps represent around 60% of the OTC markets, which was worth $692 trillion as of June 2013, according to the latest available data from the Bank for International Settlements.

What happens next?
Esma on Wednesday sent the standards to the European Commission, which has three months to endorse them. Once that happens they will enter into force after 20 days, providing there are no objections from the European Parliament and the European Council.

When does clearing actually start?
It will be introduced on a phased basis, depending on what type of firm you are, to help alleviate the pressure on those that have not traditionally had to clear their trades. The first group of participants comprises companies that already clear interest rate swaps and are members at an Emir-approved clearing house ̶ these are primarily banks and brokers. They will have to clear trades six months after the standards come into force – so the clearing mandate for them will take effect around the middle of 2015.

The second group includes other financial institutions, such as buyside companies, and alternative investment funds. This group will need to start clearing 12 months after the rules are published – around the end of 2015. The third group includes financial institutions with a low level of activity in interest rate swaps — this group will need to start clearing 18 months after the rules are published, so well into 2016.

The final group of participants affected by Emir comprises non-financial firms such as large corporates — Esma has given these companies three years from when the standards come into force.

Why has the phase-in period for larger financial institutions changed from the draft?
The shorter, 12-month phase-in period for larger financial institutions within the second category is the biggest change in the final standard. They were originally set for an 18 month phase-in. However, this caused concern in part because Emir includes a ‘front-loading’ obligation, which requires private swap trades that are agreed during the phase-in period to be cleared retroactively. This means that a private swap trade entered into at the start of 2015 would have to been cleared 18 months later.

Many market participants argued that changes to market conditions during this phase-in period could influence how that swap is valued and the collateral held against it - the longer this period, the more complex that process would become. Esma said on Wednesday that the “later the clearing obligation comes into effect, the longer counterparty risk might not be manged adequately”.

Has anything else changed in the final standards?
The other major change was the inclusion of a separate category for low users of derivatives, who will have an 18-month phase in period. Esma said it wanted a solution where a “big bang situation and the resulting bottleneck risks are addressed more effectively”.

What about swaps in other currencies?
The scope of the clearing mandate is limited to interest rate swaps denominated in G4 currencies. Notable omissions include swaps denominated in currencies of the Nordic countries such as the Swedish krona, and also the Polish zloty.

Hans-Ole Jochumsen, president of global market services at Nasdaq OMX - which operates exchanges in the Nordic region - described the omission of the krona from the clearing mandate as “very surprising”. Esma said that it was “already conducting the analysis on some of the classes denominated in other currencies, including the Nordic region currencies as well as the Polish zloty, as to whether they should be subject to the clearing obligation”. It said a new consultation on these currencies would be launched in the coming months. It did say, however, that it “can add at any moment classes that were not previously declared to be subject to the clearing obligation”.

What about other asset classes?
Esma has already conducted a consultation covering the clearing of credit default swaps, which started in July and ran until September 18. The final standards on clearing for these products can be expected in the coming months, according to an Esma spokesman. A consultation for the clearing of OTC FX non-deliverable forward products began on Wednesday, while a consultation for OTC commodity products is expected in the coming months, the spokesman said.

It is not expected that there will be a mandate for clearing OTC equity products in the near future. Esma said that a number of participants had said a clearing obligation on equity OTC derivatives would require “more time and consultation with market participants”.

What about indirect client clearing?
One of the biggest problems around Emir is how smaller and less-sophisticated institutions begin clearing their trades for the first time. They cannot afford the costs of becoming a direct member of a clearing house, and will typically turn to clearing members to clear trades on their behalf. However, it is often uneconomical for direct clearing members to offer clearing services to smaller clients.

As a result such clients may use a regional bank that is itself a client of a direct clearing member. However, many banks are reluctant to provide these services because of the impact different bankruptcy rules across EU member states have on resolving default situations. Esma said on Wednesday that it was “aware that, as of today, there does not appear to exist any offer for indirect client clearing”. It said it was “considering the reasons for this lack of offer, including the commercial incentive and the existence of some legal impediment to provide indirect clearing services”.